Key Contacts

Shareholders' Agreements In Nepal

2018-12-01

1. INTRODUCTION

Shareholders’ agreement (can be described as an agreement between shareholders of a company on regulating their rights and duties as shareholders of a company. In most companies, the relationship of shareholders and governance issues are primarily regulated by memorandum of association (“memorandum”), articles of association (“articles”) and the Companies Act 2006 (“Act”). They regulate matters relating to the capital structure, board, shareholders meetings, conduct of meetings, voting, transfer of shares, and other governance issues relating to a company.

Shareholders may wish to enter into separate shareholders’ agreement for the following reasons:

to confer rights that may not be suitable to be contained in articles;

to regulate certain special relationships between shareholders;

to protect minority rights conferred by the articles;

to bind the shareholders on matters before the incorporation of a company; and

to secure rights to obtain damages in breach of agreement.

In Nepal, shareholders’ agreements are commonly entered into by shareholders of companies with foreign investment to regulate the relationship between foreign investor and local investors, and companies where private equity and venture capital funds have invested in to regulate the relationship between the investor and the founders. Shareholders’ agreements are not very common in start-ups, SMEs, family owned businesses and public companies, but could also be very useful in such contexts to properly regulate shareholder relationships.

2. TYPES

The Act provides for two primary shareholders’ agreement. Unanimous agreement between all shareholders of a private company is categorized as consensus agreement. An important and interesting feature of the consensus agreement is that it is also able to bind future shareholders of the company. Further, consensus agreement supersedes the provision of the memorandum and articles. It can also be entered pre-incorporation and is able to bind the company.

General shareholders’ agreement can be entered into by two or more shareholders of either a public or a private company. Section 187 of the Act provides that they are binding on the parties but they do not bind the company or other shareholders that are not a party to the agreement. They also do not supersede the provision of the memorandum and articles.

Foreign investment approval mandatorily requires a joint venture agreement to be submitted to the approving authorities. It is usually entered into by all shareholders, local and foreign, to a proposed new company with foreign investment. Accordingly, this can also be classified as a consensus agreement.

Shareholders’ agreements are jointly or separately undertaken during investment transactions with a share purchase agreement or share subscription agreement. Often, shareholders’ agreement is merged with provisions found in subscription agreements and are called shareholders’ and subscription agreement or investment agreement.

3. COMMON CLAUSES

Shareholders’ agreements come in all shapes and sizes and vary from company to company. Some provisions commonly included in the agreement are:

capital and financing;

board and shareholders meetings;

quorum and special voting rights;

minority protection;

sale and transfer of shares (e.g. first refusal and first offer rights);

Shareholders’ agreements governed by Nepalese law need to fulfil general formalities for execution of written contracts set out in the Muluki Civil Code. It can be signed by hand and does not require thumbprint execution. Rubber stamps are required to be affixed in agreements signed by companies.

Section 187 of the Act requires the shareholders entering into shareholders’ agreement to submit two copies of the agreement to the company within 15 days of execution and for the company to submit the agreement to the Office of the Company Registrar within 15 days of receipt from shareholders. A pre-incorporation consensus agreement is required to be submitted to the Office of the Company Registrar together with the application to register a company.

5. LIMITATIONS

Shareholders’ agreements have the following limitations:

provisions that may be prejudicial to the interests of the company or the minority shareholders are not enforceable;

shareholders’ agreement that are not consensus agreement will only be enforceable against the parties and not against the company or other shareholders;

provisions in the shareholders’ agreement may not contradict mandatory provision of the Act; and

certain provision of the shareholders’ agreement may be considered as unlawful interference on the statutory powers of the company.

In certain circumstances, it may be better to ensure that certain provisions of the shareholders’ agreement are entrenched in the memorandum or articles to ensure enforceability.

6. MINORITY PROTECTION

Minority protection clauses are provided in shareholders’ agreements to ensure that the interests of minority shareholders in a company are protected. The following minority protection clauses are commonly included:

Board representation

Shareholders’ agreement may provide for certain shareholders to appoint a certain number of board members. This can also be entrenched in the articles as a class right. It should be noted that section 87 of the Act provides a special right to corporate shareholders to appoint directors in proportion to their shareholding in the company.

Information rights

Special information rights are often provided to shareholders in shareholders’ agreements. Information rights ensure that the company and other shareholders continue to provide information relating to the operation of the company to the shareholders.

Quorum

Quorum provisions are frequently included in shareholders’ agreement to ensure that proceedings of shareholders or board meetings of the company do not take place without the presence of certain persons. These types of provisions have the potential cause deadlock in a company; accordingly, deadlock resolution provisions may also need to be included. Flexible drafting should ensure that the provision is not deemed as prejudicial to the interests of the company, in which case it may risk being deemed unenforceable.

Affirmative voting rights

Affirmative voting rights can be included in shareholders’ agreements as section 187 of the Act provides that shareholders’ agreement can also regulate matters relating to the use of voting rights. Careful drafting should ensure that such provisions are not deemed invalid due to being prejudicial to the interests of the company. Interests of the shareholders benefiting from such rights should be balanced with the interests of the company. Appropriate deadlock resolution mechanism should ensure that any deadlock caused by affirmative voting rights are resolved.

6. SHARE TRANSFER RESTRICTIONS

Section 42 of the Act provides that shares may be sold as movable assets subject to the provisions of the articles and agreement between shareholders. The company is entitled to refuse to transfer the shares not sold in accordance with the provisions in the articles or the agreement. Generally, share transfer restrictions are imposed in a private company due to the personal nature of business partnerships. The following restrictions are commonly placed for transfer of shares:

Free transferability

Shareholders’ agreement may provide that the parties will be free to transfer the shares without restrictions or without providing any prior notice to the company or other shareholders. Free transferability provisions are not commonly seen in private companies in Nepal. Articles would also need to be amended or modified for the implementation of free transferability provision. Model articles of private companies in Nepal provides free transferability among existing shareholders.

Right of first refusal

The selling shareholder is required to identify a legitimate third party before the offer is proposed to the existing shareholder. Shares may only be transferred to the proposed buyer only if the other shareholders do not wish to purchase the shares. If authorized, the sale can be undertaken to the proposed third party at the price specified in the transfer notice. Implementation of this clause will take time and the seller will also incur the additional cost of marketing to the third party. Model articles provides this mechanism to transfer shares to a person who is not an existing shareholder.

Right of first offer

The selling party offers the shares to the existing shareholders without identifying the third party. Under such clause the selling party proposes the price of the shares and the non-selling party has the first opportunity to accept the offer. If the offer is not accepted by the non-selling party, the selling party can offer the shares to the third party at a price not less than previously offered to non-selling party. This clause will usually avoid the initial cost of marketing the offer to the third party.

Tag-along

Tag-along can be described as a right to join other selling shareholder at same price and terms. If a shareholder is proposing sell its shares to the third party, such transfer cannot not be completed unless the original seller ensures that the buyer buys all the shares of the other shareholders. This is also considered as an exit route for minority shareholders, if the majority is selling to a third party.

Drag-along

Drag-along is provision which allows a selling shareholder to force other shareholders to sell their shares along with them to a third-party buyer. This clause allows the majority shareholder to “drag” the remaining minority shareholders with them to sell their shares to the third party at a same price and terms. It is unclear how effectively drag along clauses can be enforced in Nepal and if specific performance orders from courts and tribunals would be available to force the transfer of minority shares to a third party.

7. GOVERNING LAW AND DISPUTE RESOLUTION

Shareholders’ agreements relating to Nepalese companies are usually governed by the laws of Nepal. However, parties are able to agree on foreign law to govern shareholders agreement under section 709 of the Muluki Civil Code. This is common in companies with foreign investment. The Foreign Investment and Technology Transfer Act 2019 does not restrict parties from contracting under foreign law.

Disputes relating to shareholders agreement can either be resolved by courts or arbitration. Parties should carefully select the venue and jurisdiction of the dispute resolution forum. Dispute resolution clauses should be very carefully drafted as there is a potential overlap of jurisdiction under Nepalese law as District Court has jurisdiction to resolve contractual disputes and the High Courts have jurisdiction to resolve disputes under the Companies Act 2006.

Arbitration is commonly selected as a dispute resolution method in shareholders’ agreement particularly transactions involving foreign investors. Arbitration clauses should be drafted with an objective to ensure that arbitration is conducted professionally and impartially, arbitrators are swiftly appointed, application to the courts is not required to appoint arbitrators, and court is not prevented from issuing injunctive order to preserve the status quo until the dispute is finally resolved. Nepalese law permits both international and domestic arbitration.